The Mortgage Morass

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Few questions provoke a heated partisan response as reliably as what to do about Fannie Mae and Freddie Mac. It's not hard to understand why. During the economic collapse, the government had to bail out the failing mortgage giants at enormous cost to taxpayers-- at last count, more than $150 billion. Yet two years later, they dominate the troubled mortgage market, while private lending shows few signs of returning.

At heart, the dispute is an ideological one, about the proper role of government. Republicans downplay Wall Street's excesses and blame Fannie and Freddie for causing the crisis by succumbing to political pressure to make loans to poor people who were not creditworthy. They consider removing government from the mortgage business an urgent priority, and many new Republicans were elected by vowing to make that happen.

For obvious reasons, Democrats hesitate to defend the mortgage giants. But most believe they provided a crucial path to homeownership for generations of middle-class Americans (and, later, working-class poor), before collapsing under a pile of subprime mortgages. Fannie and Freddie may be tarnished beyond redemption, but many Democrats still believe that government should support homeownership through mortgage finance.

As soon as next week, the White House will introduce its long-delayed reform plan and House Republicans will begin hearings on Fannie and Freddie. Because these will center on a massive and costly government failure, and thus lend credence to the Republican charge that government is dangerously inept, they are sure to be a circus.

But all the attention will be misleading. For all the drama, there really isn't much of a debate over what to do about Fannie and Freddie. In the short term, liberals and conservatives basically want the same thing, which is to gradually reduce the government's role in the mortgage market. Why only gradually? Because with housing weak and private lenders uncertain to step in, a sudden withdrawal could be catastrophic.

There's also an emerging consensus about how this could be done. Last month, the conservative American Enterprise Institute put forward a plan (.pdf) to wean borrowers from Fannie and Freddie and foster private lending. It would do this by gradually lowering conforming loan limits and loan-to-value ratios, meaning that the mortgage giants would purchase ever smaller loans and require greater down payments. They would also start ratcheting up fees. Over time, Fannie and Freddie would purchase fewer mortgages and charge more to do so.

Treasury officials have something similar in mind. What's striking is how modest these plans are in relation to the urgent rhetoric. Years from now, government would remain a major player in mortgage finance. That's partly because powerful Republican interest groups, from realtors to home builders, understand that while government may be unpalatable it plays a vital role.

Over the long haul, the plans do diverge. The main source of contention in Congress will be whether the government should continue backing mortgages for the middle class. Republicans wish to privatize this part of the market, and point out that countries like Canada, Germany, and Australia have achieved comparable rates of homeownership without anything resembling Fannie or Freddie. Getting the government out of the mortgage business, they argue, would spare taxpayers future bailouts.

Many Democrats, including administration officials, believe some government role is necessary, possibly in the form of mortgage guarantees. They contend that foreign governments implicitly back their banks, the same murky situation that blew up Fannie and Freddie. Full privatization, they argue, would also cause rapid consolidation in the mortgage industry by wiping out small lenders who couldn't carry the cost of 30-year mortgages. The 30-year mortgage Americans are accustomed to might even disappear, because banks wouldn't want to bear the costly prepayment and interest-rate risk currently borne by Fannie and Freddie (one reason why 30-year mortgages are rare outside the United States). They also fear that private markets would freeze up in a crisis, necessitating another bailout. Better to make that guarantee explicit, they argue.

But even here, the similarities are considerable. Everyone wants to reduce government's role and make it explicit, so privately owned corporations aren't trying to carry out a public mission. Most recognize that won't happen soon. And even the conservatives at American Enterprise Institute concede a government role in helping poor but creditworthy borrowers, possibly through the Federal Housing Administration or something like the Federal Home Loan Banks, as Massachusetts Representative Barney Frank would prefer.

Before that can happen, though, Republicans will have to reconcile their promises to swiftly abolish Fannie and Freddie with the reality that we're probably stuck with them for a long time.

Joshua Green writes a weekly column for the Boston Globe.

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Joshua Green is a former senior editor at The Atlantic.

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